A Guide for Raising Equity Investment By MSMEs
Transcript of A Guide for Raising Equity Investment By MSMEs
Raising EquityInvestmentBy MSMEs
A Guide for
Raising EquityInvestmentBy MSMEs
A Guide for
3Contents | A Guide for Raising Equity Investment by MSMEs
Exit Route
SECTION 4
Success Stories
SECTION 5 46
2Contents | A Guide for Raising Equity Investment by MSMEs
MSME Background
Contents
What is MSME
MSME & Investment Lifecycle
SECTION 1 6
Sources of Funds Sources of Funds for MSME
Debt Financing
Equity Financing
Debt vs. Equity Financing
SECTION 2 10
Equity Funding Sources of Equity Funding
Government of IndiaInitiatives for VC Industry
State Government Initiatives
Leading MSME VC & PE Investors
Advantages of Equity Funding
Process of Equity Funding
Pitch for Equity Funding
Valuation
Term Sheet
Due Diligence
Important issues in preparingfor the Equity Fund Raising
Investor Relationship
SECTION 3
44
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driven by inadequate interaction between
MSMEs and equity providers.
‘A Guide for Raising Equity Investment by
MSMEs’ is an attempt to bridge the distance
between MSMEs and equity providers. The
guide provides a step by step process for
MSMEs to prepare themselves for equity
investment by discerning investors. MSMEs
can benefit from the information that has
been brought into this concise document,
including potential sources of funding and
successful experience sharing of
entrepreneurs.
I hope MSMEs will be able to make the best
out of this guide in their aspiring growth
journey.
Manoj MittalDeputy Managing Director
SIDBI
A. K. SharmaSecretary
MSMEs will have to dream and act big for India to take its rightful place in the global
economy. Accordingly, the MSMEs will need to go for substantial equity infusion for
enhancing their debt absorbing as well as risk taking capacity.
As part of the Atmanirbhar Bharat Abhiyan, the Government has announced various
measures for MSMEs including Debt, Sub-debt and equity financing Schemes. However,
in order to avail the benefits from the equity/equity like schemes, there needs to be
greater understanding amongst MSMEs about the pros and cons of equity financing.
Moreover, Government schemes can only work as catalyst in creating an active
ecosystem with participation from discerning private investors. Partnering with
experienced equity investors who can handhold MSMEs in their growth journey, can
lead to better corporate governance, technology upgradation and market expansion.
Against this backdrop, the initiatives of SIDBI Venture Capital Ltd. (SVCL), a wholly
owned subsidiary of SIDBI, to bring out ‘A Guide for Raising Equity Investment by
MSMEs’ is apt and very timely. The guide elucidates various issues of equity financing in
an easy to understand and relatable way. I would encourage MSMEs to take advantage of
this guide and prepare themselves for raising equity investment and partner with
investors for a bright future, better growth and for creating value for all stakeholders.
I am also happy to note that the guide would be published in other regional languages.
Once again, I congratulate the SVCL and SIDBI team for taking this noble initiative and
wish them all success.
Finance is lifeblood of any
business, MSMEs being no
exception. While there has
been substantial
improvement in the
availability of debt capital
for MSMEs from formal institutional
sources in India, the access to equity and
equity like capital has continued to elude
them.
Both demand and supply side factors have
contributed to constrict flow of equity to
MSMEs. The demand side constraints have
largely been driven by misconceived
notions in the minds of MSMEs such as fear
of losing ownership control, compulsion for
more disclosure, ceding seats on boards to
the investors, etc. On the supply side, there
have been challenges of having access to
appropriate information and awareness
The Government of India, in
recent past, has taken
several initiatives to
strengthen MSMEs to realise
the avowed goal of
“Atmanirbhar Bharat”. One
of the key areas of thrust has been
facilitating access to equity capital to
MSMEs through Fund of Funds operations.
While access to debt capital has been well
streamlined and understood by MSMEs, the
awareness regarding equity capital has
generally been limited among MSMEs. It is
felt that there is need for an organised effort
to enhance the awareness regarding equity
capital among MSMEs.
‘A Guide for Raising Equity Investment by
MSMEs’ is a step in the right direction to
guide MSMEs to prepare themselves and
raise equity investment to face a globalised
market. The guide sets out succinctly the
major issues as well the steps involved in
the equity fund raise process. I am sure the
booklet will be of immense help to the
MSMEs and encourage them to access the
equity fund raising market.
I congratulate SVCL and SIDBI for
publishing this booklet and hope that it will
encourage next generation MSME
entrepreneurs to grow manifold.
Dr. Archana HingoraniManaging Partner
Siana Capital Management LLP
7MSME Background | A Guide for Raising Equity Investment by MSMEs
Revised classification of MSME applicable w.e.f 1st July 2020as per the notification published in the Gazette of India
Source: https://msme.gov.in/know-about-msme
Composite Criteria:Investment in Plant & Machinery/Equipment and Annual Turnover
MSME
Investment in Plant and Machinery or Equipment:Not more than Rs. 1 crore
Annual Turnover:Not more than Rs. 5 crore
MICRO
Investment in Plant and Machinery or Equipment:Not more than Rs. 10 crore
Annual Turnover:Not more than Rs. 50 crore
SMALL
Investment in Plant and Machinery or Equipment:Not more than Rs. 50 crore
Annual Turnover:Not more than Rs. 250 crore
MEDIUM
What isMSME?
Micro, Small and Medium Enterprise
9MSME Background | A Guide for Raising Equity Investment by MSMEs
Self, Friends & Relatives Funding
Initial investment by founder
Angel Funding / Seed Funding
Individual or entities with surplus cash
EARLY STAGE
Banks/Financial Institutions
Term Loans and Working Capital Loans
Venture Capital / Private Equity
Equity infusion leads to higher networth and can be used to leverage debt
Equity investor can be a partner to rely on and should be of sound reputation
Partner can improve systems and processes to benefit the business in the long run and help to build value
GROWTH /EXPANSIONSTAGE
Initial Public Offer
Expansion of business by raising funds from public.
Exit opportunity for existing investors.
Equity Funding & Acquisitions.
Listing on NSE Emerge & BSE platform.
MATURE STAGE
8MSME Background | A Guide for Raising Equity Investment by MSMEs
MSME &InvestmentLifecycle
Medium Mediumor
Fixed
Medium
11Sources of Funds | A Guide for Raising Equity Investment by MSMEs
Sourcesof Funds
There are several funding options emerging in India and entrepreneurs can
explore to raise funding from alternative sources to meet their requirements.
Some of the sources available for exploration are as follows:
AMOUNTAVAILABLE
COST OFFUNDING
AVAILABLERESOURCES
ISSUES
SELFFUNDING
FAMILY &FRIENDS
INTERNALACCRUALFROMBUSINESS
LOANS ORDEBTS
EQUITYINVESTOR
Amount may not be available in sufficient
quantity
Process may be fast but smaller amounts from many individuals may
prove difficult to manage
Amount may not be sufficient and may not be
available when needed most
Loans process faster than friends and family but lenders may demand
security such as property etc. Strict terms of repayment exists.
Relatively longer time. Investor would be a
shareholder.
High expectations of growth and financial
returns. Joint decisions with the equity partner
with respect to major (not day-to-day) issues
Very Limited Very Low Very Limited
Limited Low Limited
Limited Low Limited
High Variable Medium
13Sources of Funds | A Guide for Raising Equity Investment by MSMEs
DebtFinancing
NEW AGEFINTECH
PLATFORMS
VENTUREDEBT
BONDS &DEBENTURES
BANK OR NBFC’SLOANS
The company can issue bonds/debentures to qualified
institutional buyers/ retail investors. However, the same
involves significant compliance costs as compared to other
sources of debt.
New Age Fintech Platforms also provide an alternative to
MSME companies to raise debt. The cost of debt in such a
case may be higher than traditional sources.
BONDS & DEBENTURES
FINTECH PLATFORMS
The traditional way of generating debt funds is by
procuring loan from financial institutions such as Banks &
NBFCs for general purpose or to meet working capital
requirements. Such debt financing would include general
purpose borrowing, equipment finance, working capital
financing such as factoring (recourse & non-recourse) etc.
Debt financing solutions provided to early stage enterpris-
es without collateral and equity dilution. Generally,
venture debt has a higher cost of interest as compared to
other debt sources.
LOANS FROM BANKS/NBFCS
VENTURE DEBT
Debt Financing means when a firm raises money for working capital or
capital expenditures through means of financial instruments such as
debentures or bonds (with or without embedded conversion and other
options) or through other means such as equipment finance loans,
general purpose corporate loans etc. Debt financing typically has a
fixed/floating interest liability with a defined repayment tenure.
15Sources of Funds | A Guide for Raising Equity Investment by MSMEs
EquityFinancing
Equity financing means the raising of
capital through sale of shares i.e. providing
the investor an ownership interest in the
company.
Generally, equity financing involves
allocation of ordinary equity shares to the
investors. However, quasi equity
instruments such as convertible preference
shares, warrants and convertible
debentures may also be used as a quasi
equity instrument to raise equity financing.
The investment could be by way of only one
such instrument or it could be a mixture of
such instruments.
The valuation could be fixed at the time of
investment or it could be in convertible
instruments, where valuation could be
pegged to a milestone.
While debt would generally have a fixed
cost, equity does not. At the same time,
because of the higher risk, the expectations
of return from equity investment are higher.
Equity shares are also known asOrdinary shares or as Owned Capital
EQUITY SHARES
EQUITY & QUASI EQUITY INSTRUMENTS
Cumulative/Non-Cumulative
Redeemable/Non-Redeemable
Participating/Non-Participating
Convertible/Non-Convertible
Preference shares with Call/Put Option
PREFERENCESHARES
Secured/Unsecured
Redeemable/Non-Redeemable
Convertible/Non-Convertible
DEBENTURES
17Sources of Funds | A Guide for Raising Equity Investment by MSMEs
DebtFinancing
EquityFinancing
V/S
The decision to raise equity or debt financing would involve a trade off
based on the company’s current and targeted debt-equity ratio. Further,
it would also be a decision based on the ability of the company to access
such source of funding while maximizing the return to its investors.
Various other factors such as willingness to dilute the ownership,
additional cost of compliance with equity funding, commitment to
existing lenders and investors, the credit rating of the company, the end
use of the funds etc. are considered in deciding the source of financing.
DEBT EQUITY
OWNERSHIP
REPAYMENT
MANAGEMENTINFLUENCE
OBLIGATIONS
CLAIMS ONINCOME &
ASSETS
Dilution of ownership interest in the business
No dilution of ownershipinterest in the business
Equity shareholders havevoting rights along with rights
to board representation.
None, unless some specialconditions have been agreed on.
Stock has no maturity date
No obligation to pay dividends
Debt has a maturity date
Payment of Interest & Repaymentof Principal according to
fixed schedule
Subordinate to DebtSenior to Equity
COST Generally cost of equity is inproportion to the risk return profileof the company as Equity investor
have residual interest in the company.
Generally cost of debt is cheaperas they have priority in repayment
over Equity shareholders.
COLLATERAL No Collateral Collateral dependent
TAX BENEFITS No tax benefitsTax shield on interest payments
19Equity Funding | A Guide for Raising Equity Investment by MSMEs
Sourcesof EquityFunding
Equity Financing refers to supplying
capital to an enterprise in return for an
ownership share in it.
Equity Investors can be broadly classified
into three categories, based on the lifecycle
stage of MSME they invest into:
Although organized VC/PE funds have
been investing in India for over 25 years,
the MSME sector continues to be
underserved by formal external equity.
Equity as a source of financing is under
utilized and the prevalence of investment
by venture capital and angel investors is
low when compared to other countries.
MSMEs in India generally rely on friends &
family as sources of equity.
Venture Capital and Alternative Invest-
ment Funds registered with the Securities
and Exchange Board of India can be found
at the links given below:
https://www.sebi.gov.in/sebi-web/other/OtherAction.do?doRecog-nisedFpi=yes&intmId=21
https://www.sebi.gov.in/sebi-web/other/OtherAction.do?doRecog-nisedFpi=yes&intmId=16
Indian Private Equity & Venture Capital
Association (IVCA) provides information
about their members, including venture
capital and private equity firms as well as
knowledge partners. This can be accessed
at the link below:
https://ivca.in/our-members/
Invests in Growth and Mature Stages and
invest a larger ticket size
PRIVATE EQUITY FIRMS
Invests in Early Stage MSMEs and ticket
size is relatively small
Invests in Breakeven stages, normally
known as quasi-equity finance
ANGEL INVESTORS
VENTURE CAPITAL FIRMS
21Equity Funding | A Guide for Raising Equity Investment by MSMEs
Governmentof IndiaInitiativesfor VCIndustry
Under the Startup India program, the Government created the FFS with a corpus of ₹ 10,000
crore to provide funding support for Startups, over a period of XIV and XV Finance commis-
sion cycles. The Fund was set up with the approval of Union Cabinet in June 2016.
The operational guidelines were issued as per Cabinet approval. The FFS is managed by
Small Industries Development Bank of India (SIDBI) and contributes to the corpus of Alterna-
tive Investment Funds (AIFs) for investing in equity and equity linked instruments of various
Startups.
FUND OF FUNDS FOR STARTUPS (FFS)
With Government intervention, the SRI Fund scheme would be able to channelise diverse
variety of funds into underserved MSMEs and address the growth needs of viable and high
growth MSMEs.
SRI Fund, in the form of Fund of Funds (FoF), will be oriented towards providing funding
support to the Daughter Funds for onward provision to MSMEs as growth capital, in the form
of equity or quasi-equity, for :
Enhancing equity/equity like financing to MSMEs and listing of MSMEs on Stock
Exchanges
Supporting faster growth of MSME Businesses and thereby ignite the economy and
create employment opportunities;
Supporting enterprises which have the potential to graduate beyond the MSME
bracket and become National / International Champions;
Supporting MSMEs which help make India self-reliant by producing relevant
technologies, goods and services.
SRI Fund is a Fund of Funds with initial support from Government of Rs. 10,000 crore, which
will be further leveraged to Rs. 50,000 crore.
SELF-RELIANT INDIA FUND (SRI FUND)
Ministry of MSMEMinistry of Micro, Small and Medium EnterprisesGovernment of India
Ministry of FinanceGovernment of India
DPIITDepartment for Promotion of Industry and Internal TradeMinistry of Commerce & IndustryGovernment of India
23Equity Funding | A Guide for Raising Equity Investment by MSMEs
StateGovernmentInitiatives
Bhamashah Techno Fund of ₹ 500 Crores for Startups has been introduced to
give an open sky to the potential Start-ups of the state of Rajasthan.
Government of Uttar Pradesh has established a UP Startup Fund with a
corpus size of ₹ 1,000 crore.
RAJASTHAN
UTTAR PRADESH
Government of Bihar has created Bihar Startup Fund Trust with a corpus of
₹ 500 crore for funding Startups.
BIHAR
Kerala Startup Mission (KSUM), the nodal agency for Startup initiative in
Kerala is partnering with SEBI accredited Venture Capital Funds for the
creation of corpus fund for supporting the emerging startups in the State.
KERALA
GVFL Ltd., supported by the State Government of Gujarat is one of the oldest
venture funds in the country.
Government of Karnataka has operationalised fund of funds for investing in
venture funds that invest in Startups in various sectors. Following Venture
capital funds have been launched in the State with key focus on selected
sectors:
Karnataka Semiconductor Venture Capital Fund (KARSEMVEN
Fund) with ₹ 93 crore
KITVEN 3 (Bio-tech) with ₹ 50 crore
KITVEN 4 (Animation Visual Effects Gaming and Comics) with
₹ 20 crore
GUJARAT
KARNATAKA
2524Equity Funding | A Guide for Raising Equity Investment by MSMEs Equity Funding | A Guide for Raising Equity Investment by MSMEs
LeadingMSME VC &PE Investors
Aavishkaar
BanyanTree Growth Capital
DSG Consumer Partners
Everstone Capital
Fireside Ventures
GVFL Ltd.
IFCI Venture Capital Funds Ltd.
InvAscent Capital Partners
Karnataka Asset Management Co. Pvt. Ltd.
Kedaara Capital
Kotak Private Equity
LGT Lightstone Aspada
Lighthouse Advisors India Pvt. Ltd.
Matrix Partners India
Motilal Oswal
NABVENTURES Ltd.
Norwest
Orbimed
Rabo Equity
Rajasthan Asset Management Co. Pvt. Ltd.
SBICAP Ventures Ltd. (Neev Fund)
Sequoia Capital India
SIDBI Venture Capital Ltd.
Sixth Sense Ventures
Somerset Indus Capital Partners
https://www.aavishkaarcapital.in/
http://banyantreefinance.com/index.php
https://dsgcp.com/
https://www.everstonecapital.com/
https://firesideventures.com/
http://www.gvfl.com/
http://www.ifciventure.com/
https://www.invascent.com/
http://www.kitven.com/
http://www.kedaara.com/index.html
https://alternateassets.kotak.com/kotak-private-equity-fund.php
https://www.aspada.com/
http://www.lhfunds.com/index.html
https://www.matrixpartners.in/
https://www.motilaloswalgroup.com/Our-Businesses/Private-Equity
https://nabventures.in/
https://www.nvp.com/india/
http://www.orbimed.com/en
https://www.raboequity.com/index.php
http://www.rvcf.org/
https://sbicapventures.com/neev_fund/
https://www.sequoiacap.com/india/
www.sidbiventure.co.in
http://www.sixth-sense.in/
http://www.somersetinduscap.com/
27Equity Funding | A Guide for Raising Equity Investment by MSMEs
Possible new opportunities with no fixed
repayment obligation on the company
With equity financing, you might form informal partnerships
with more knowledgeable or experienced individuals. Some
might be well-connected, allowing your business to potentially
benefit from their knowledge and their business network.
Investors are often prepared to provide follow-up funding as
the business grows.
LEARN AND GAIN FROM PARTNERS
FOLLOW UP FUNDING
As compared to raising debt, equity funding does not have to be
dependent on any security or collateral in order to raise funds
but is based on business plans and revenue models.
NO COLLATERAL
With equity financing, there is no loan to repay. The business
does not have to make a monthly loan payment which can be
particularly important if the business does not initially
generate a profit. This in turn, gives the freedom to channel
more money into a growing business.
LESS BURDEN
Advantagesof EquityFunding
29Equity Funding | A Guide for Raising Equity Investment by MSMEs
Appointing advisors / consultants if required, to advise and guide the company on the process of equity raising
Prepare business plan
Identify and approach the investors.
Identify and position key selling points
Vendor Due Diligence
(This process takes usually 2-6 months)
Preparation of Pit ch/Preliminary DueDiligence
Preliminary meetings with investors
Procuring term sheets
Preliminary Due Diligence
Prepare proposed valuations
Negotiate valuation & other terms
(This process takes up to 2-3 months.)
Evaluation &Negotiation
Evaluate proposed financial structures
Signing definitive purchase & sale agreements for Equity subscription and Shareholders agreement.
(This process takes 1 month depending upon time taken for negotiations.)
Exe cution & Closing
Post Compliances Post compliance with conditions given, funds are drawn down from the investors.
(This usually takes 1 month depending on time taken for compliances)
Processof EquityFunding
31Equity Funding | A Guide for Raising Equity Investment by MSMEs
The company should elaborate on its capital structure and its
capital requirements for the future. The company should give
information on how the proceeds will be utilised for expansion
purposes.
Give information pertaining to the company, its legal form of
operation, when it was formed/incorporated, the principal
stakeholders and key personnel of the company.
FINANCIAL REQUIREMENTS
BUSINESS POSITION
The company has to provide information about its achievement
of various milestones and the developments within the
company that are essential to the success of the business.
MAJOR MILESTONES
The business plan should provide the evolution of the company.
The business concept needs to be described, including its
product and market it is going to serve. It should elaborate on its
key revenue generating segments and future plans.
The business plan should provide historic financial data for
analysis purpose. This mainly involves elaborating on
important financial points of the business including sales,
profits, cash flows and return on investment.
BUSINESS BACKGROUND
FINANCIAL FEATURES
Elementsof Business
Plan
33Equity Funding | A Guide for Raising Equity Investment by MSMEs
Pitchfor EquityFunding
Business Pitch is a presentation by one or
more people to an investor or group of
investors for raising equity.
Pitch should generally have the following
structure in order to pitch for financing:
Introduction
Core Team
The Business Model
Valuation and the amount ofInvestment required
Key Milestones
Strategy to achieve key milestone
Competitive position
The business exit strategy
While preparing the pitch, the company
should also assess the objectives of the
investor and the company’s key selling
points including its financial ratios.
An investor while making an investment decision, does careful analysis of financial
parameters to find out true worth of the company. This can be done by examining the
company’s P&L account, balance sheet and cash flow statements. Therefore, an investor shall
use the financial ratios as a guide to know more about the company. Similarly, the company
can use these ratios to market itself to the investors. Some key ratios are as follows:.
Price/Earnings Ratio
PEG Ratio
Price/Sales Ratio
Price/Book Ratio
Useful to value the company depending on
the industry.
PRICE RATIOS
Return on Assets
Return on Equity
Net Profit Margin
Used to assess the profitability of the entity
vis a vis its revenue or assets or equity
employed.
PROFITABILITY RATIOS
Debt to Equity orDebt to Capital Ratio
Debt to Assets Ratio
Debt to EBITDA Ratio
Used to assess the capital structure/fixed
payment obligations of the company
LEVERAGE RATIOS
Asset Turnover Ratio
Inventory Turnover Ratio
Receivable Turnover Ratio
Determines how well the assets employed
are utilised in the business.
EFFICIENCY RATIOS
Current Ratio
Quick Ratio
Interest Coverage Ratio
Debt Service Coverage Ratio
Helpful to assess the short term cash
flow/working capital position to meet short
term liquidity needs.
LIQUIDITY RATIOS
Analyse yourCompany
34Equity Funding | A Guide for Raising Equity Investment by MSMEs
Financial ratios are dynamic and
Vary from time to time
Vary depending on the industry
May be affected by business factors such as seasonality
Shall be affected due to change in accounting policy/methods
Therefore a company must adjust for such factors in its analysis if it substantially affects the output.
Financial Ratios are also useful for
Trend Analysis: Analyse for patterns in historical and the projected period.
Benchmarking: Compare with companies in the similar industry and with similar size
Analyse yourCompany
35Equity Funding | A Guide for Raising Equity Investment by MSMEs
KeyConsiderations
of EquityInvestorsGROWTH
PROSPECTS
INDUSTRYOUTLOOK
MANAGEMENTTEAM
ROBUSTNESSOF BUSINESS
MODEL
Competitive landscape
Strong product development
High barriers to entry
Multiple markets and products
Experience
Commitment
Alignment with investors
Execution capability
Changing customer preferences
Presence of disruptive technologies
Industry growth prospects
Regulatory issues
Large customer base
Strong supply chain
Stable and recurring cash flows
Low capital expenditure requirements
What InvestorsLook For
Objectives ofthe Investor
Key Considerations of Equity Investors -
What Investors Look For
36Equity Funding | A Guide for Raising Equity Investment by MSMEs
Investors are interested in investment
opportunities, which are generally
expected to provide a target return. The
main idea is to ensure that the companies
are able to perform so well that returns
follow naturally from their growth and
operations.
“The primary objective of the investors is to generate superior returns and therefore they look to identify and invest in profitable and scalable business ventures including innovative business model or new products & technologies.”
Investment decisions are generally based
on fundamentals of the company.
Generally, investors are likely to aim to
take significant minority stakes based on
total investment in an investee
companyand would look to play an
impactful and active role with
representation on the board of directors of
such investee companies in order to help
create value for such company. A few
investors may like to also take majority
ownership stake.
Investors would discuss with the
company and agree on a well-defined exit
path for the investor after the period of
investment is over. Exit alternatives
generally include:
sale of investor’s stake to another investor;
sale of company / investor’s stake to a strategic buyer;
buyback of investor’s stake by entrepreneur/promoter/company;
stock exchange listing.
The higher the valuation, the less dilution
the entrepreneur will have to encounter.
The lower the valuation, the investor will
have more upside potential and less risk,
creating a higher motivation for the investor
to assist in the company.
Valuation of an enterprise could be done by
any one method or a combination of
methods. A business could be valued by
sales revenue multiple, EBITDA multiple, net
profit multiple, discounted cash flow, book
value etc.
For example, if an enterprise has achieved a
net profit of Rs. y crore, the investor may
value it by a multiple of x times of its net
profit, resulting in an equity value of Rs. xy
crore. The following page provides two of
the most popular valuation methods which
are preferred by equity investors while
valuing a company.
A business valuation is a general process of
determining the economic value of a whole
business or company unit.
The valuation put on the business is a critical
issue for both the entrepreneur and the
investor.
The key factors that will go into a
determination of valuation include:
The experience and past success of the founders
Future projections of the company
The market size of the company’s business
Company’s progress towards a viable product
The recurring revenue opportunity of the business model
Valuations of comparable companies
Economic environment
Valuation
3938Equity Funding | A Guide for Raising Equity Investment by MSMEs
ValuationMethods
Discounted Cash Flow Method:
While using the Discounted Cash Flows
or Earnings (of Underlying Business)
valuation technique to estimate the Fair
Value of an Investment, the Enterprise
Value of the Investee company is
derived by using reasonable
assumptions and estimations of
expected future cash flows (or expected
future earnings) and the terminal value.
The said cash flows are discounted to
the present by applying the appropriate
risk-adjusted rate that captures the risk
inherent in the projections.
The Enterprise Value is then adjusted
for surplus or non-operating assets or
excess liabilities and other
contingencies and relevant factors to
derive an Adjusted Enterprise Value for
the Investee Company.
Financial Projections
Free Cash Flow to Firm
Discounting Factor
Enterprise Value
Adjustments forDebt, Cash and Surplus Assets,
if any
Business Value
Explicit Period Terminal Value Comparable Companies Method:
The value is determined on the basis of
multiples derived from valuations of
comparable companies, as manifest
through stock market valuations of
listed companies.
This valuation is based on the principle
that market valuations, taking place
between informed buyers and informed
sellers, incorporate all factors relevant
to valuation. Relevant multiples need to
be chosen carefully and adjusted for
differences between the circumstances.
To the value of the business so arrived,
adjustments need to be made for the
value of contingent assets/liabilities,
surplus asset and dues payable to
Preference Shareholders, if any, in order
to arrive at the value for equity
shareholders.
Revenue / EBITDA
Industry Revenue / EBITDA multiple
Enterprise Value
Adjustments forDebt, Cash and Surplus Assets,
if any
Business Value
Equity Funding | A Guide for Raising Equity Investment by MSMEs
41
DueDiligence
After the investor has gone through the
business plan, there would be multiple
rounds of meetings with the promoters and
the management team. The investor would
take up internal processes for deciding on
making the investment. If investor decides
on going ahead with the investment, it
would provide a term sheet setting out the
major terms of investment including
amount, valuation, instruments and rights
of the investor.
The entrepreneur may then want to
understand the term sheet and negotiate
some of the clauses, if required, with the
investor. After the terms are agreed upon,
the company may formally accept the terms
and proceed ahead with other steps such as
third party due diligence.
If the due diligence exercise is satisfactory,
the investor may then go ahead with the
investment. Prior to disbursement of funds,
promoters will be required to execute all the
documents stipulated under the terms of
investment, including Shareholders’
Agreement / Subscription Agreement etc.
and comply with the conditions precedent
to the investment.
The company would need to evaluate the
investor and the term sheet based on
Reputation
Investment objectives and eligibility criteria
Fund life and exit time horizon
Experience in MSME investing and past record in handling MSME companies
Amount of investment, valuation and rights asked for by investor
Experience of investing in company’s particular industry
Active or passive role
Due Diligence is an audit or investigation
conducted by a third-party financial expert
and reviews all financial records of the
company. It is a final precautionary
measure undertaken before entering into
an agreement. Due diligence can be either
done by the company (sell side) or investor
(buy side).
Due Diligence by the Company (referred to
as Sell side or Mock DD or Vendor DD)
Typically, prior to equity financing, the company itself may initiate a due diligence (called vendor due diligence) which should involve a full due diligence of the company.
A strong focus is on the financial business drivers that determine the future results.
Vendor (sell-side) due diligence will increase the quality of the offers received and maximize the value of a business.
Due Diligence by the Investor (referred to as
Buy side DD)
Similarly, the investor may initiate buy side due diligence which
generally involves an investigation and analysis to assess the investment suitability and the key issues facing the company.
The strong focus is on the financial business drivers that determine the historic and projected results. Buy-side due diligence runs through all business areas of a company.
The objectives of buy-side due diligence are:
To get a detailed understanding of the company
To get an understanding of possible risks in all areas of the company
Assess the competency of managers and senior business leaders
To identify business drivers that will be critical to the future success of the company
To get input for future legal documents
Equity Funding | A Guide for Raising Equity Investment by MSMEs
TheTermSheet
4342Equity Funding | A Guide for Raising Equity Investment by MSMEs
The due diligence process can uncover
inconsistencies in the processes of the
business, including compliances with
regulatory filings, secretarial filings,
payment of taxes, contracts and agreement,
delays and defaults, contingencies etc.
The cost and time incurred for this exercise
is relatively less compared to the benefits.
To fasten the due diligence process, the
company can create a data room, which can
be either physical or a virtual online one.
Access to this data can be provided to the
investor and the third-party financial
agency which is undertaking the process.
Ongoing or historical delinquencies with
lenders / financial institutions / banks and
historical issues of a legal nature, especially
of a criminal nature are likely to lead to
discomfort.
Once these are brought to light, a process of
setting them right has to be put in place, for
the long-term effectiveness of the business.
The due diligence process should generally
include introducing written procedures /
checklists / standard operating procedures
etc. Typically, some MSMEs may not have it
in place at all. It may also include human
resource related contracts and agreements
with senior staff such as confidentiality and
non-compete agreements etc.
This makes the business more attractive and
valuable. Therefore, when the fund-raising
is being undertaken, the buyer / investor
will not enter into further negotiations as
the issues would have been resolved or
would be in the process of being resolved.
This also reduces the risk for the investor. A
clean track record shows investors that the
promoters are credible as entrepreneurs and
have intentions of sticking around and
running the business in compliance with the
laws.
Due Diligence:
Adding ValueDue Diligence:
How to be Prepared?Due diligence may typically be a painful
process for MSMEs. Company management
may be very confident of completing the
entire process in a short time. However, that
is usually not the case as it can be time
consuming and may cover a wide range of
issues and areas such as given below.
Due diligence process is not a fault-finding
process. It also includes rectification of
non-compliances and improvement in
systems. This is ultimately to the benefit of
the company.
It pays to be prepared, by setting the house
in order, before commencement of the
process. Depending on the level of
preparedness of the company, the time taken
to complete the due diligence would vary.
Company management could keep the
following in mind while preparing for due
diligence:
Having adequate internal systems for data capture, storage and retrieval.
Be up to date with compliances regarding corporate governance, secretarial and regulatory issues.
Have adequate number of quality personnel to interact with the due diligence teams to understand their data requirements and provide the information in specific formats.
TYPES AND AREAS OF DUE DILIGENCE
Commercial
Financial
Tax
Legal
Strategic
Environmental
Human Resources
Equity Funding | A Guide for Raising Equity Investment by MSMEs
4544Equity Funding | A Guide for Raising Equity Investment by MSMEs
Important IssuesIn Preparing forThe Equity FundRaising
InvestorRelationship
Investors look to invest in enterprises that:
Are open to change
Are willing to accept strategic and operational support in order to achieve rapid growth.
Investors would generally have the option
for a nominee director and/or an observer
on the board of directors of the company.
Investor would insist on regular board
meetings with the presence of investor
nominee.
Important decisions would need investor
approval such as business strategy, hiring at
senior level, employee compensation
policies, raising debt or equity and large
contracts etc.
Investors would want to spend significant
time in developing a relationship with each
company, which may go a long way in
creating value and help face future
challenges.
Investors may provide significant help in
building appropriate systems and processes,
putting up a strong top management team,
managing team aspirations, smooth and fast
execution of projects.
Being fully prepared for the entire exercise
can reduce the time taken. Company
management should analyse the following
risks and prepare accordingly:
Equity raising exercise being undertaken for the first time – no experience
Lack of clarity in strategy, objectives, business plan
Business lacks growth potential / may not be able to generate returns as per investor’s requirement
Fund raising process started at the last moment when the business is in urgent need of funds
Delays in providing information to the investor as promoters may be simultaneously running the business as well as coordinating with potential investors
Advisors appointed by the company for the fund-raising exercise are inexperienced
The entire process may also have certain
expenses by way of advisors’ fee, travel, cost
of compliances etc. which may have to be
borne by the company.
Investors would generally require :
The enterprise to be a company form of organisation. If it is a proprietorship or partnership, it may need to be converted into a company or its business to be transferred to a company. A company structure is generally required to facilitate the fund raising by way of subscription to equity or quasi equity.
A functional board of directors.
An organisation structure for the management team, with roles and responsibilities clearly defined.
A strong finance team, to provide reliable data, in formats required by the investors, during the fund-raising process. The finance team would help in effective financial reporting and analyses, cash flow management, cost optimisation, proper maintenance of books of accounts.
Share profit: Investors will expect a share of
the profits. However, it could be a
worthwhile trade-off if benefiting from the
value they bring as financial backers and/or
their business acumen and experience.
Perceived loss of control: As most
entrepreneurs would have been running
their enterprise independently, they might
feel uncomfortable with the rights required
by investors. However, as financial investors
would generally take a minority stake in the
company, they would not be running the
operations (except in majority ownership by
investors). The investor needs to be taken
into confidence for major business decisions.
The investor’s prime interest would be in
exiting the investment at a later date and
making a profit from their investment.
Potential conflict: Sharing ownership and
having to take the investor along in major
decisions could lead to stresses if there are
differences in vision, management style and
ways of running the business. It can be an
issue to consider carefully and thrashing out
while negotiating the terms with the
investor. At the same time, the promoters
can expect the investor to be a partner and
good sounding board while taking major
decisions.
Time consuming: Raising equity finance is
demanding, time consuming and may be
costly. It may take management focus away
from the core business activities during the
fund-raising exercise (short-term). This
exercise would however be to the long-term
benefit of the business once equity is raised.
Equity Funding | A Guide for Raising Equity Investment by MSMEs
ExitRoute
47Exit Route | A Guide for Raising Equity Investment by MSMEs
The investors will sell their stake in the business to another private equity firm.
This is an exit strategy where the management or the promoters of the company buy back
the equity stake from the investors.
SECONDARY SALE
REPURCHASE BY THE PROMOTERS
Buyback is one of the ways by which a company provides an exit route to the shareholders by
purchasing their shares.
COMPANY BUYBACK
This is the least favourable option but sometimes will have to be used if the promoters of the
company and the investors have not been able to successfully run the business.
LIQUIDATION
One of the ways to exit is to come out with an Initial Public Offering of the company and
raise fresh funding, as a part of the IPO to the public. Investor may sell their shares in the IPO
or sell their shares after the company gets listed and the shares start trading on the exchange.
Strategic acquisition or trade sale, where the company invested in is sold to another suitable
company. This is one of the exit routes for private equity funds. The buyer will usually have a
strategic advantage in acquiring this business as they may complement each other. For this
reason, the buyer will often pay a premium to acquire such a business.
INITIAL PUBLIC OFFER (IPO)
STRATEGIC ACQUISITION
Equity investors usually have an investment horizon of 5-7 years and plan
to exit after that, making a substantial profit on their investment. There are
many exit strategies that institutional equity investors can use to offload
their investment. The following are the exit routes for the equity investors:
49
SuccessStories
The National Stock Exchange of India Limited was
established in 1992 as the first dematerialized electronic
exchange in the country. Its SME platform is known as
NSE Emerge
https://www1.nseindia.com/emerge/
The BSE Ltd. was established in 1875 and it is Asia's oldest
stock exchange. Its SME platform is known as the BSE SME
Platform
https://www.bsesme.com/index.aspx
These platforms can provide exit route to the investor.Some success stories of listing on these platforms are provided in the following pages.
The National Stock Exchange of India Ltd. and the BSE Ltd.
(formerly Bombay Stock Exchange) are leading stock
exchanges in India and offer platforms for listing of SMEs.
NSE EMERGE
BSE SME
Success Stories | A Guide for Raising Equity Investment by MSMEs
In FY 2012, the company had two small
subsidiaries in Saudi Arabia and Australia.
Today, in FY 2020 the company has global
presence with four subsidiaries in Saudi
Arabia, Australia, Brazil and Chile.
“We raised capital through IPO in 2012 and became the first company to list on NSE-EMERGE. Apart from raising the funds, listing helped us to upgrade our Governance and adopt best practices, which has its own value. Listing has also improved the profile of our Company.”
- K.J. Joseph and Thomas John, Promoters,
V.A. George Managing Director, Thejo
Engineering Limited
51Success Stories | A Guide for Raising Equity Investment by MSMEs
ThejoEngineeringLimited
0
350
300
250
200
150
100
50
INR
CR
OR
ES
1 3 8 . 9 2
3 0 4 . 4 9
7 . 8 13 0 . 3 6
T OTA L R E V E N U E P RO F I T A F T E R TA X
F Y 2 0 1 9 - 2 0
F Y 2 0 1 2 - 1 3Growth in the company post raising equity
from FY 2013 to FY 2020
0
350
300
250
200
150
100
50
INR
CR
OR
ES
S E P 1 8 2 0 1 2 A U G 3 1 2 0 2 0
Approximate Market Capitalisation M A R K E T C A P I TA L I S A T I O N
7 0
2 6 0
Thejo Engineering Limited was
incorporated in 1974 as a partnership firm at
Gudur, Tamil Nadu between Shri K.J. Joseph
and Shri Thomas John. It became a Public
Limited Company in 2008. It is currently
based in Chennai with manufacturing
facility at Ponneri.
The company was into repair and
maintenance services to companies using
conveyor belt systems and manufacturing
complementary products such as conveyor
belt accessories, mill liners, hoses etc.
Events in the company for generating
capital in FY 2013 :
The company raised Venture capital of
INR 2 Cr from India Opportunities Fund
The first company to list on NSE
Emerge Platform and raised INR 19 Cr
through IPO
SL is also a wholesaler for Tamil Nadu
Newsprint and Papers Ltd in Gujarat and for
Asia Pulp in Gujarat and Rajasthan. Its
sticker sheets are used in soap and pharma
industries, and stationery business.
It got listed on the NSE Emerge in July 2017.
Since its listing in FY18, its market cap
valuation has increased appoximately 5x in
FY20, thereby unlocking value and opening
up potentially new funding opportunities
and better access to funds.
Shrenik Limited (SL) was incorporated in
2012. SL is primarily engaged in the business
of trading of different types of papers in
Gujarat and Rajasthan through distribution
channel. They offer coated papers, notebook
papers, photocopy papers, folding box
boards, etc.
The company serves customers with variety
of papers like copier, maplitho, coated paper,
FBB Board and a speciality paper
commodity royal executive bond.
Besides being a wholesaler they have also
introduced their own brand. Its customer
base is in Gujarat and Rajasthan.
53Success Stories | A Guide for Raising Equity Investment by MSMEs
0
800
700
600
500
400
300
200
100
INR
CR
OR
ES
4 2 8 . 0 9
7 9 6 . 8 3
4 . 1 8 1 1 . 6
T OTA L R E V E N U E P RO F I T A F T E R TA X
F Y 2 0 1 9 - 2 0
F Y 2 0 1 6 - 1 7Growth in the company post being listed
on the NSE Emerge in July 2017
0
700
600
500
400
300
200
100
INR
CR
OR
ES
J U L 1 8 2 0 1 7 A U G 3 1 2 0 2 0
9 8
4 7 8
ShrenikLimited
Approximate Market Capitalisation M A R K E T C A P I TA L I S A T I O N
VOL operates a manufacturing facility at
Sarigam Industrial Estate having an
installed capacity of 4,800 metric tonnes per
annum.
VOL got listed on the SME Board of the BSE
in the year 2016.
In the year 2017, VOL acquired Abhilasha
Tex-Chem Pvt. Ltd.
Valiant Organics Limited (VOL) was
incorporated in 1984.
VOL is a chemical manufacturing company
mainly engaged in the business of
manufacturing and marketing various types
of chlorophenols in India. Chlorophenols are
mainly used in agro-chemical industry,
pharmaceutical industry, dyes industry as
well as in manufacturing of cosmetics and
veterinary drugs.
VOL started with exports in the year 2008.
VOL also offers customised specification of
Chlorophenols as per the customer needs.
55Success Stories | A Guide for Raising Equity Investment by MSMEs
Growth in the company post raising equity
from FY 2016 to FY 2020
0
3500
3000
2500
2000
1500
1000
500
INR
CR
OR
ES
O C T 1 4 2 0 1 6 A U G 3 1 2 0 2 0
9 6
3 , 3 0 7
0
800
700
600
500
400
300
200
100
INR
CR
OR
ES
5 3 . 4 7
6 9 6 . 3 1
1 0 . 3 1
1 4 0 . 5 3
T OTA L R E V E N U E P RO F I T A F T E R TA X
F Y 2 0 1 9 - 2 0
F Y 2 0 1 5 - 1 6
ValiantOrganicsLimited
Approximate Market Capitalisation M A R K E T C A P I TA L I S A T I O N
In 2012, Pragati India Fund, a fund managed
by Pragati India Asset Management via P.I.
International L P, invested INR 22.75 Cr in
JEL.
JEL has 5 wholly owned subsidiaries such as
Shivpad Engineers Pvt Ltd in Chennai,
India, Jash USA Inc in Texas, USA, Mahr
Maschinenbau GmbH in Vienna, Austria,
Engineering & Manufacturing Jash Ltd, in
Hong Kong and Rodney Hunt in Texas, USA.
JEL got listed on NSE Emerge in the year
2017.
Jash Engineering Limited (JEL) is a leading
member of the Jash Group which was
founded by Mr. Jashbhai Patel in the year
1948.
Jash Engineering Ltd is based in Madhya
Pradesh.
JEL is engaged in manufacturing of wide
range of products used in water intake
systems, water and waste water pumping
stations and treatment plants, storm water
pumping stations, water transmission lines,
power, steel, cement, paper & pulp,
petrochemicals, chemical, fertilizers and
other process plants.
57Success Stories | A Guide for Raising Equity Investment by MSMEs
JashEngineeringLimited
0
350
300
250
200
150
100
50
INR
CR
OR
ES
1 6 1 . 1 6
2 8 5 . 6
1 0 . 0 82 0 . 0 9
T OTA L R E V E N U E P RO F I T A F T E R TA X
F Y 2 0 1 9 - 2 0
F Y 2 0 1 6 - 1 7Growth in the company post being listed
on the NSE Emerge in July 2017
160
195
190
185
180
175
170
165
INR
CR
OR
ES
O C T 1 1 2 0 1 7 A U G 3 1 2 0 2 0
1 7 0
1 8 9
Approximate Market Capitalisation M A R K E T C A P I TA L I S A T I O N
Inc, Zioncom (Hong Kong) Technology Ltd,
Apple India Private Ltd, Sennheiser
Electronics India Private Ltd, Gopro
Cooperatief U.A, TPV Technology India
Private Ltd, Printronix, SIEPL India
Electronics Private Ltd, Vintron Informatics
Ltd and Samsung India Electronics Private
Ltd.
CPDL got listed on NSE Emerge platform in
the year 2017. Since its listing in FY17, its
market cap valuation has increased approx.
3x in FY20, thereby unlocking value and
opening up potentially new funding
opportunities and better access to funds.
Creative Peripherals Distribution Limited
(CPDL) was incorporated in 1992.
CPDL distributes consumer electronics to
retailers and resellers in India. It distributes
IT, imaging, lifestyle, and telecom products.
CPDL is a broad based distribution model
which is based on multiple products and
multiple brand strategy.
It has partnered with a number of
renowned brands for distribution in the
country such as Rapoo Technologies Ltd,
Lino Manfrotto + Co S.p.a, Transcend
Information Inc, ViewSonic International
Corporation, Olympus Corporation, Belkin
59Success Stories | A Guide for Raising Equity Investment by MSMEs
CreativePeripheralsDistributionLimited
0
500
400
300
200
100
INR
CR
OR
ES
2 1 2 . 0 1
4 5 9 . 0 6
1 . 3 7 . 7 8
T OTA L R E V E N U E P RO F I T A F T E R TA X
F Y 2 0 1 9 - 2 0
F Y 2 0 1 6 - 1 7Growth in the company post being listed
on the NSE Emerge in 2017
20
160
140
120
100
80
60
40
INR
CR
OR
ES
A P R 1 2 2 0 1 7 A U G 3 1 2 0 2 0
4 8
1 4 5
Approximate Market Capitalisation M A R K E T C A P I TA L I S A T I O N
SIDBI Venture Capital Limited
Small Industries Development Bank of India
Swavalamban Bhavan, C-11, G-Block, 2nd Floor,
Bandra Kurla Complex, Bandra (East),
Mumbai 400 051
www.sidbiventure.co.in